The British pound tumbled on Friday after a European official warned a no-deal split with the UK was the likeliest outcome, and analysts warned of wild swings to come.
The pound fell as much as 0.9 per cent against the dollar to a low of $1.3175 on Friday, its weakest since November 16, after European Commission president Ursula von der Leyen told the bloc's leaders that Britain is now more likely to leave the EU without a trade deal.
With talks either set to collapse or succeed this weekend ahead of a Sunday deadline set by Brexit negotiators, both outcomes could trigger outsized moves in the currency.
"If a deal is reached, the pound could surge past the $1.35 handle it touched last week, before potentially heading towards 1.40," Fawad Razaqzada, market analyst at Think Markets, told The National.
However, if the UK leaves the European Union without a deal, this could see the currency take a hit because markets were pricing in an eventual deal.
“This outcome will probably come as a shock and could see sterling get a good pounding, sending cable possibly to $1.20," said Mr Razaqzada.
“Brexit talks are going to the wire and I wouldn’t be surprised if the deadline is pushed further out, as after all this is what has been happening repeatedly in recent years.”
The UK quit the EU in January but remains an informal member until December 31 when it will finally leave the block after 48 years. While both sides want a trade deal, the negotiations are deadlocked.
Friday's fall puts the pound on course for a 1.8 per cent drop this week, the worst performance since September.
The uncertainty has seen sterling weaken against all of its G10 peers this week, while also posting a weekly loss against all major Asian currencies, according to Han Tan, market analyst at FXTM.
“The worst-case scenario of a no-deal Brexit risks the cable erasing much of the 4 per cent gap that currently sits between current levels and its 200-day simple moving average over the coming months," he said.
“On the flip side, a last-minute deal could see the pair breaching the long-term resistance level of $1.35, though the runway to the upside appears shorter compared to the downside.”
With sterling under pressure, the increasing possibility of a no-deal outcome will add further fuel to bears of a UK economy already weighed down by a difficult road to economic recovery, said Richard Hunter of interactive investor.
“Ironically, this has had a marginally positive effect on the FTSE 100 given the exposure of the index to overseas earnings, with the drop of 13 per cent in 2020 representing some improvement from the lower levels earlier in the year," he said.
Options traders have grown used to piling up Brexit hedges, with the relative premium to hedge against sterling losses over a three-week period, which covers the end of this year, now hovering near its highest since the aftermath of the 2016 Brexit referendum.
“A lot of premium has been spent on pound hedges for lots of deadlines over four to five years that never amounted to anything,” said Jordan Rochester, a strategist at Nomura International. Attention is now turning to New Year’s Eve, when without a deal, Britain will trade under World Trade Organisation rules and sterling could fall to $1.25 by mid-2021, according to a Bloomberg survey.
However, there is still some hope that a Brexit trade deal will be secured by the deadline.
“There are also reports of a contingency plan being drafted in Brussels that would maintain air and road connectivity between the UK and the EU. If enacted, such measures are expected to blunt the economic fallout from a no-deal Brexit and this is also helping limit sterling’s immediate downside,” Mr Tan said.
Meanwhile, the euro is expected to fare better than sterling in the event of a no-deal Brexit, with the euro-pound currency pairing strengthening 1.26 per cent on Thursday, registering its biggest single-day advance in three months.
On Friday, the pound lost 0.6 per cent against the euro to stand at £0.92, a two-and-a-half month low.
“Still, a last-ditch Brexit trade deal could unwind some of those gains in EUR/GBP, while a no-deal outcome may send the currency pair surging towards £0.93 in the immediate aftermath,” said Mr Tan.